Excerpts from the interview:

IRDA plans to publish a national standard for valuation of insurance companies in the next few months. Is Max New York Life currently declaring embedded value (EV)?

Life insurance policies are long-term contracts, where the policyholder pays a premium to be covered against a possible future risk (such as mortality or morbidity) or for building a savings corpus. The policyholder pays the premium over a long tenure, but much of the expenses to set up the policy are incurred in the first few years.

This leads to accounting losses for life insurers in the initial policy years. However, over the full policy tenure, the life insurance company has the potential to make profits. These future profits, however,do not get reflected in the books of account, but do get embedded in the business. The embedded value of a life insurance company is the present value of future profits plus adjusted net asset value. Max New York Life is the first company to declare its EV last year. We are committed to voluntarily declaring EV on an annual basis. For the financial year 2007-08, the EV was Rs 1,316 crore.

We think that EV is the most acceptable method of representing the present value of business sold by a life insurer.

However, a business has to be valued on a going-concern basis. This means that the company will continue to sell more policies that will result in profits in future. Such future profits from expected future business, that is, structural value plus the embedded value, is known as appraisal value, which is the true representation of the value of a life insurance company.

Since most of private players are selling market-linked plans, how can they be sure of future premia?

The question mark on renewal premium arises if there has been a mis-selling of life insurance products. We understand that there is huge concern on ULIPs being sold as three-year investment products. However, if the policyholder has been sold the right policy based on his needs and aligned to his key financial goals, the possibility of lapse decreases significantly.

At Max New York Life Insurance, our need-based selling has resulted in one of the best conservation ratios in the Indian life insurance industry. In the financial year 2008-09, our conservation ratio was 83 per cent.

Most of the private players are reporting huge losses though they have been in the business for more than eight years. Will they be allowed to tap the market at a premium to the face value?

Life insurance is a long gestation business. Generally life insurance companies break even after the eighth or ninth year of operation. However, if growth in the first year premium income is high, the breakeven period may even be longer.

The accounting profit or loss is also a function of expansion plans of the company. Fixed operating expenditure would be higher in the initial years when the company is in expansion phase, as in the first couple of years investments like new offices do not reach optimum productivity.

Given the low life-insurance penetration, it is a strategic imperative for life insurance companies to increase their distribution depth and width. There is ample opportunity since India is both uninsured and underinsured. Since most life insurers have pursued aggressive expansion plans, the accumulated losses have continued to mount for them.

We believe the growth in Indian life insurance industry will continue albeit at a slower pace. Life insurance companies that started their operations in 2001-02 may achieve breakeven in the next 2-3 years. Valuations of life insurance companies will depend largely on embedded value as it will a good barometer of intrinsic value in the business. However, in a fast growing market like India, future prospects from the business will also play a key role in determining the premium to face value.

How is the new valuation likely to be different from the present valuation method?

Embedded value is an assumption of various economic and non-economic factors. Currently, there is no standardised way adopted by the industry to calculate the embedded value.

The formalisation of this step of making it mandatory for every life insurance company to declare its EV will lead to standardisation.

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